Bitcoin Trading: Interpreting Order Books

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Posted onApr 22, 2013

In this article we will review how read a bitcoin order book, how to interpret a bitcoin order book, and how to spot common market manipulation techniques by properly understanding order book dynamics.

What is an Order Book?

No, the other kind of Ledger

An order book is a ledger containing all outstanding orders – instructions from traders to buy or sell bitcoin. An order to buy is called a “bid” and an order to sell is called an “ask.” Bids and asks are paired up as soon as their requirements are fulfilled, resulting in a trade. For introductory purposes there are two primary order types to know:

Market order – buy or sell immediately for the best available price. These orders are filled by immediately pairing buyers and sellers with orders currently in the books.

Limit order – buy or sell a set number of bitcoins at a specified price or better. An example order would be: Bid $1000 to buy ฿10 at $100.

Understanding order book volume

To understand how to interpret order books, we have to first understand how to read them. In the below, you can see current trading price and volume, as well as the bid and asks currently in the order book. The numbered green, red and yellow boxes were added for the purposes of this explanation.

The red boxes indicate sell orders and the green boxes indicate buy orders. For both sides of the order book (bid and ask / buy and sell) the annotated numbers indicate the following:

The price level

The total volume of bitcoin in the order book at that price level

The cumulative volume of all orders between the current trading price and a given price level

The yellow box (#4) highlights a snapshot of the order book $2 above and below the current trading price (approximately $128). In this example, there are 124 BTC of bids at $126 and 344 BTC in cumulative bid volume between $126 and the current price of $128. If a trader were to place an order to sell 300 BTC at $126, they would be filled by 2.5 BTC at $128, 220.4 BTC at $127 and the remaining 77.1 BTC at $126.

Order book depth (total quantity of orders) can be used as a way to quantify the market’s intentions to buy and sell. One way traders can view order book depth, in addition to the method above, is to use a depth chart that shows the cumulative bids and asks in the current market. This technique illustrates the total volume on the order books starting from the value of the latest transaction. In the depth chart below you can see bitcoin trading near $123.5 with bids starting at $122.5 and asks starting at $125. The $2.5 between the highest bid and lowest ask is known as the bid-ask spread.

The green and red lines continue upwards, showing the cumulative bids at any given price level, reflecting the same information as the previous chart we looked at, but with a better visual representation of the order book.

One important note is that the depth of orders is generally much smaller than actual trading volumes, especially during large moves. In the top half of the chart below, we can see several periods where the 1 hour volume was over ฿30,000, however there were relatively small net movements in the price (of only about $5). Compare this to the limit orders on the order book at the bottom of the chart – a ฿30,000 market order bid would move the price up $20 to $149.

So what is really happening here? Most traders are not leaving their orders on the books, but reacting to movements and timing in the market. There is little reason for a trader to reveal his market expectations and trading positions when you can react almost instantly to market movements.

Bid/Ask Walls

If a trader wants to place orders at pre-determined price points, he can do so automatically without showing his orders on the books by using simple trading software. That said, there are some advantages that would lead a trader to reveal his intentions by placing large, public limit orders.

One common technique is to place a large limit order called a “wall” – referred to as bid walls or ask walls, depending on the type of order. It is fairly common to see walls of ~฿1,000 at even dollar values; however large walls of ฿5,000 can have a significant impact on market sentiment. Large limit orders are often placed to advertise intention and to affect the distribution of orders around the wall (illustrated in the example below). Traders will often move orders ahead of the wall to get executed first.

Lets look at the recent reaction to a ฿5,700 bid wall placed at $123. Traders with orders to buy at a price below $123 observe the reduced likelihood that their limit orders would be filled and move orders ahead of the wall – we can see an almost ฿2,000 increase in orders at $124 and $125. Then the trader removes the wall at $123, however the newer orders have remained:

Recognizing potential manipulation

As we’ve shown, an order book may not accurately represent a market – unlike historical data, current pricing and live trading volume. At any point before an order is executed (matched with a counterparty) it can be canceled. The temporary nature of order books makes analysis challenging and fraught with potential attempts at manipulation. Traders can place large limit orders that they have no intention of filling in an attempt to give the appearance of a desired market sentiment.

When smaller traders view a large wall ahead of them, the logical reaction is to move orders ahead of it to prevent the wall from absorbing all potential trades. As others do this in mass, a second wall is created with legitimate orders. The manipulative trader effectively moved up the limit orders on the books, and increased the price people are willing to pay. There are two potential motives for this:

Selling – the trader is trying to reduce the size of his BTC position, he can influence a higher asking price before offloading his BTC. Watch for a fairly large sell order after the bid wall is removed to recognize this.

Building support – the trader has already established a BTC position and is trying to reduce the vulnerability of a large sell order moving the market downward. Usually this scenario is followed by a fairly large BTC purchase and a lot of momentum higher.

Questions?

Thank you to Chris, one of our twitter followers, for requesting this order book overview. We appreciate feedback, so feel free to leave questions about this material in the comments below, or reach out to us on twitter @TheGenesisBlock.

Update (4/30): For all of our French-speaking readers, Karl Chappe at francebitcoin.com has translated this article to French